What to Watch for as Washington State Crafts a Millionaire's Tax

Entering 2026, Washington joins the growing list of states looking to implement new taxes on the "rich" – those earning more than $1 million per year. In December 2025, Gov. Bob Ferguson signaled his approval for a new 9.9 percent state income tax applied against individuals earning above the $1 million threshold. Ferguson's announcement sets the stage for a momentous 60-day legislative session, which will run from January 12 to March 12, 2026, in the capital city of Olympia.

The 60-day legislative session will give the controlling Democratic Party an opportunity to draft a law that imposes a tax on high-income individuals, notwithstanding current legal limits against a tax on personal income and state constitutional limits on property taxes. From 1934 to 2010, Washington voters defeated 10 straight citizens initiatives to impose a state income tax on individuals or businesses. More recently, in 2024, two citizens initiatives that were intended to ratchet back the existing capital gains tax and state's cap-and-tax Climate Commitment Act both failed at the ballot box, with more than 61 percent of voters approving a retention of these taxes on higher-income individuals and companies.

Ferguson said that he would support a so-called "Millionaire's Tax" provided it was based only on annual net income and included an inflation adjustment that would increase the million-dollar threshold over time. He wants to earmark part of the funds from this tax to shore up Washington's Working Families Tax Credit, which currently pays up to $1,290 per year to eligible families, and zero out the business and occupation (B&O) tax on businesses earning up to $1 million per year.

Washington faces an estimated $2 billion shortfall in its remaining two-year budget cycle. Much of the upcoming short session in Olympia will focus on plugging that budget gap or tinkering with other taxes and spending requests. In 2025, the legislature approved an increase to Washington's B&O tax and estate tax, along with a significant expansion of sales tax to new categories of service income. (See Holland & Knight's previous alert, "Washington State Budget Triggers Higher Business, Capital Gains and Estate Taxes in 2025," July 15, 2025.)

Ferguson has stated that the Millionaire's Tax will have no effect on the current budget because it will not be implemented until 2029 at the earliest. He also floated the idea of a state constitutional amendment to codify the $1 million limit and inflation adjustment mechanism.

No Clear Path

The Millionaire's Tax faces several obstacles before it can be implemented, including:

• In March 2024, the legislature codified into law the text of a then-pending citizens initiative, Initiative 2111, which bans the state and any city or county from imposing a tax on personal income. Lawmakers will presumably have to overturn this law in order to move forward on the Millionaire's Tax.
• If passed into law in 2026, the Millionaire's Tax will almost certainly face a constitutional challenge. In 2023, the Washington Supreme Court upheld the state's capital gains tax statute, but many of the arguments in that case will get a new hearing if the Millionaire's Tax moves forward.
• The Millionaire's Tax could also face another citizens initiative or a lengthy fight over an amendment to the state constitution. Under Washington law, a constitutional amendment requires two-thirds approval in both the state Senate and House of Representatives, plus a majority vote among citizens.

Whatever the legal and political obstacles to the Millionaire's Tax, the actual text of the law will need to be drafted in the pending 60-day legislative session. Thus, all eyes will be on Olympia lawmakers as they propose and debate the details of this tax. Here are three key topics to monitor as the debate ensues:

Is Washington's Millionaire's Tax Going to Tax All Pass-Through Income, or Will Lawmakers Adopt Exemptions to Protect Favored Industries?

When Washington created the capital gains tax in 2022, lawmakers followed the standard blueprint of starting with a taxpayer's federal long-term capital gain, then modifying this number by subtracting state-specific exemptions and deductions. Thus, to calculate Washington capital gains, the state currently excludes federal capital gains that are derived from timber income (including timber-related capital gain distributions from real estate investment trusts (REITs)), fishing quotas and certain cattle, horse and livestock transactions, as well as the sale of "goodwill" by car dealerships. Real estate is also excluded, although the real estate exemption is limited and does not extend to certain gains coming through tiered structures, as discussed below.

Washington also created a deduction from capital gains tax for the sale of a closely held "qualified family-owned small business." This means a business that recorded worldwide gross revenue of $10 million or less, indexed for inflation based on the consumer price index (CPI), in the 12-month period just prior to the sale date. The $10 million limit operates like a light switch – for example, selling a biotech company with zero revenue but enormous patent value can reward the seller with a 100 percent deduction of long-term capital gain in Washington state, whereas the sale of a family farm would face the full brunt of the tax if its annual gross revenue was $1 over the $10 million plus CPI limit.

The Millionaire's Tax would presumably start from the "taxable income" line of each person's federal tax return, a much broader number than long-term capital gains. If the Millionaire's Tax is intended to raise serious money, it will need to reach in and tax various kinds of pass-through income, including the operating income from partnerships, LLCs and S corporations that is reported on Schedule K-1. A key question is whether lawmakers will have the temerity to provide zero exemptions and deductions on pass-through operating income (i.e., tax all K-1 income over $1 million), or will they choose to kick out certain types of pass-through income from favored industries?

One approach would be to roughly continue with the same slate of exemptions and deductions that exist in the capital gains statute. So, for example, an S corporation or limited liability company (LLC) operating a timber property, holding fishing quota or running a car dealership would generate annual business income that would be excluded from the taxable base when calculating the Millionaire's Tax. There could be a similar deduction for annual pass-through income from qualified family-owned small businesses with less than $10 million-plus CPI in revenue. Of course, there would be a double exclusion when the timber, quota, dealership or small business is eventually sold for a capital gain. Is this fair? Is it good tax policy? Will it pass state legal and constitutional limits? Those are questions that the lawmakers will need to address.

Another important group of constituents will be closely held companies that operate with significant debt. Often, these are capital-intensive businesses, including real estate, shipping, fishing and industrial manufacturers. They also include many private companies with complex capital and debt structures, often funded with debt financing from investment funds or institutional lenders. These entities can yield significant pass-through "phantom" income, year to year, all taxable on an individual's federal return, but the income is not matched by actual cash distributions because the company uses cash to service its debt. Many debt-financed companies face legal limits imposed by lenders on cash distributions. In theory, one could craft a deduction for pass-through phantom income caused by high leverage at the operating company level, but that approach would be unorthodox and create complexity for Washington's nascent income tax regime. More likely, a new 9.9 percent tax on flow-through K-1 income will produce hardship for certain capital-intensive businesses in the private sector. It will also force a rethinking of debt and cash distribution terms in credit agreements and debt-financed transactions.

What to Do With Real Estate Income?

Washington's 2022 capital gains statute was founded on the principle that real estate gains should escape this tax. As stated in the law's findings, "[t]he legislature further intends to exempt certain assets from [capital gains] tax including … all residential and other real property." One supposes that lawmakers were mindful that the state was already taxing the gross value of real property sales under its Real Estate Excise Tax (REET). In fact, lawmakers had increased the standard REET tax rate of 1.28 percent (or 1.78 percent with local add-ons) in 2020 by creating a new graduated tax regime with top rates pushed up to 3 percent (or 3.5 percent state plus local).

There will likely be calls for retaining some form of exemption for certain real estate income in any Millionaire's Tax. Washington faces high housing costs and already exempts most rental income from the state's 1.5 percent B&O tax on gross receipts. In other words, there is historic precedent and momentum to continue a low-tax policy on rental income. A tax exemption on other forms of real property income – including mineral rights, short-term rentals and non-timber REIT income – will be harder to justify.

One bug that might be addressed in any Millionaire's Tax regime would be to fully conform Washington's new income tax system to the federal approach for single-member LLCs and holding company structures. Under federal tax law, a single-member LLC is normally disregarded as a separate entity and treated as a pure pass-through. In contrast, Washington tax policy is to respect the existence of all legal entities when imposing various excise taxes. The state continued that policy in drafting the real estate exemption under its capital gains statute. Thus, under current Washington law, long-term real estate gains are exempt from state capital gains tax when a person (including a pass-through entity) sells fee title in real estate or when a person sells the LLC interest of an entity that directly owns real property. But if an individual owns an LLC holding company, where the holding company owns a second LLC subsidiary that owns real property, and the individual sells equity in the holding company to carry out an indirect sale of the underlying real property, the individual ends up with the same federal capital gain but the Washington state exemption does not work. In many cases, the individual will owe both the Washington capital gains tax and REET tax. In effect, Washington imposes a capital gains tax on complex structures while exempting simple ones.

For drafters of the Millionaire's Tax, the problem is that holding companies and single-member LLCs are ubiquitous in the real estate sector. The same can be said for payments of interest, rent and service fees between holding companies, and single-member LLCs. If Washington sticks to a strict separate entity approach, it will need to wrestle with creating phantom income and reporting obligations for things such as rent and interest payments between entities that are disregarded on a taxpayer's federal tax return. In other words, Washington will end up creating new forms of taxable income on transactions that have no such effect at the federal level. Why do that? The easier course will be to just conform the Millionaire's Tax to federal rules on disregarded entities and flow-through income and permit Washington millionaires to count their income, net of deductions, in roughly the same manner as they do on their federal returns.

What Happens When Wage Income Is Taxed at More Than 50 Percent?

With no state income tax, Washington has long been a haven for executives seeking tax relief on wages, notably for tech industry professionals from California. In 2023, Washington added a 0.59 percent payroll tax to fund its CARES long-term care insurance program and, since 2021, Seattle has added its own Jump Start tax (at rates of 0.746 percent to 2.551 percent) on employer payrolls for wages over $194,452 in 2026. The Millionaire's Tax, if it becomes law, will put residents of Seattle comfortably in the league of major cities where the top-end wage income is taxed at more than 50 percent, as shown in the table below.

In Olympia, it is certainly possible that lawmakers will face proposals to exempt certain categories of wage income from the tax base when calculating the Millionaire's Tax, including, for example, wages paid by nonprofits, stock option exercise income or wages paid by favored industries such as healthcare or grocery stores. But it is also possible that no such changes will be made, in which case all wage income (including income of spouses) will be lumped into the pile when calculating the Millionaire's Tax.

However, a tax-everything approach on wages will create its own counter dynamic among employers and in the marketplace of compensation packages. Residency can be changed to different jurisdictions, including through part-time or at-home arrangements. Also, wages can be shifted into deferred compensation and taxed in a different state in a future year or transformed into a capital gain instrument through stock options or restricted stock. In the end, a Millionaire's Tax will likely speed up the conversion of new emerging companies into C corporations so that they can issue qualified small business stock (QSBS) to executives. Gains on the sale of QSBS are 100 percent exempt from federal capital gains tax after a five-year holding period – and that exemption carries through under the current Washington capital gains law. It would presumably remain untouched under the Millionaire's Tax, although that won't be known until the end of the legislative session on March 12, 2026.

Following Suit

Washington is not alone in its efforts to tax high earners. In 2023, Massachusetts implemented a 4 percent surtax on annual income over $1 million. There have been ballot initiatives in Michigan to adopt a similar surtax. In 2024, Minnesota implemented a 1 percent tax on net investment income exceeding $1 million for individuals, estates and trusts. In 2025, New York City's new mayor campaigned on raising the city's income tax on millionaires. However, as states weigh the pros and cons of wealth taxes, they should consider the mobility of their residents. High earners tend to flee high-tax states. Though Washington used to be a haven for the rich compared to California, its increasing taxes may see residents considering greener pastures.

Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.